Rudi’s View: Asking The Important Questions

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In this week’s Weekly Insights:

-Asking The Important Questions
-All-Weather Model Portfolio
-Gen.Ai – A New Section On The Website

By Rudi Filapek-Vandyck, Editor

Asking The Important Questions

Two-and-a-half years ago the Federal Reserve started what became one of its steepest tightening cycles in history. Two-and-a-half years and we are still debating whether the US economy, and possibly the global economy in extension, might be heading into economic recession.

Weak manufacturing and a deteriorating US jobs market are weighing on investor sentiment at the same time as record new highs for equity indices and the seasonally treacherous September-October period combine. It’s almost a guarantee for a spike in day-to-day volatility.

Can this get ugly? Of course, it can. Short-term market movements are equally determined by market specific characteristics such as concentration in popular stocks and technical trading. Investor sentiment under most circumstances is closely linked to how share prices and markets are performing.

By definition this also implies any bump in the road leads to sharper price moves, given many shares are trading on high multiples, and sharper price moves tend to impact on sentiment broadly. In simple market parlance: more selling begets more selling begets more selling. Before we truly understand what is happening we might be witnessing a new trend in the opposite direction.

As investors, how we prepare and respond to this risk depends on a few crucial factors:

-what kind of investor are we?
-what’s our specific strategy and horizon?
-what kind of assets do we own?

Almost thirty years of actively covering and monitoring financial markets have taught me more than a few invaluable lessons. One of such lessons is: there’s no such thing as a one-size-fits-all approach for investing in the share market. If we eliminate the level of experience everyone brings to the table, then those three key ingredients should guide us through the rest of the calendar year, and beyond.

But first of all, let’s start with that all-important question that is weighing on general sentiment: economic recession, yes or no?

US Recession: Waiting For Godot?

Negative reads emanating from global manufacturing, US labour market surveys and the dis-inversion of the US bond market have put the possibility of a US recession yet again front and centre of financial markets’ focus. But the debate remains far from conclusive because so many other signals and indicators are not pointing in the same direction.

Macquarie’s lateral thinker Viktor Shvets summarises the current set-up as follows:

The private sector is in good shape and despite robust multi-year tightening, investors have not witnessed a jump in bankruptcies, bad debts or widening of spreads. This is due to higher government spending. However, even more importantly, it is illustrative of benefits of massive excess capital that cushions real economies.

My own view in this matter has fundamentally changed too. Two-and-a-half years ago I thought there’s simply no chance today’s economies can withstand such a big change in central bank policing, but hey, they have all this time and I have gradually come to accept things are sufficiently different from what they were in the past to make economic recession not the default outcome from the bond yield normalisation process that has taken place.

The best way to illustrate what I am talking about is happening close to home, in Australia. My anecdotal observations are that mortgage holders are suffering, many more households are under serious duress, while numbers of small businesses are forced to pull up stumps, in hospitality in particular.

These are all characteristics of an economy that is heading for recession. If it wasn’t for immigration, Australia most likely would have already printed negative GDP numbers at least once. But it hasn’t. And it is not simply a matter of allowing enough fresh consumers into the country.

There are swathes of people in today’s society who have absolutely no idea what all the fuss about inflation, interest rates and budget pains is about. House prices have not gone down (quite the opposite) and the same applies to equities. The end outcome is an extremely bifurcated society with lots of pain and limitations on one hand but undeterred spending in the opposite corner.

It’s not any different for ASX-listed corporate Australia. As yet again highlighted during reporting season in August, the squeeze is on and it remains on for large groups of Australian businesses, while others are enjoying the most favourable conditions in their corporate lifetime to date.

The same bifurcation is on display in North America too.

The sum total for all of the above can still become a negative GDP reading for a given quarter, who knows? But if that actually matters is really dependent on what’s in the portfolio. Strong, healthy companies carried by megatrends and sustainable margins can, of course, become too popular and over-priced, but the odds remain in favour of them enjoying the same supportive characteristics irrespective of the GDP prints to follow.

Different Horses For Different Courses

 So, what kind of investor are you?

If you are a true believer in the narrative that everything is determined by ‘price’ or by ‘value’ -and there are many of your type around- you might have to prepare to be patient and deeply frustrated for longer. The US and the world at large might not be at risk of suffering a severe economic contraction, but this will not by definition prevent markets from contemplating the possibility.

This process has already well and truly begun.

Take a look at where the price of copper is trading at. And crude oil. Even iron ore. Small caps in August revealed more weakness than strength. It had been two years since we last witnessed BHP Group ((BHP)) shares trading below $40, and while that looks ‘cheap’ and ‘attractive’ in isolation, if the market continues to fear the worst possible outcomes for China, the US and the rest of the world, that share price remains poised for lower levels.

In the opposite corner we find companies like Hub24 ((HUB)), WiseTech Global ((WTC)) and Goodman Group ((GMG)); high quality performers with a proven track record that can be relied upon. Similar as in the US, such share prices are by no means cheaply priced, but investors will be reluctant to abandon these perennial winners unless things genuinely turn very ugly.

Even then, I’d still argue any outsized or prolonged weakness for such share prices remains a longer-term entry point for those not yet on board. Unless you are a true value investor, in which case these companies can never be priced cheaply enough to change your mind.

And that is fine, as long as you are fine with it.

My personal experience with the FNArena/Vested Equities All-Weather Model Portfolio (approaching ten years in January) is that owning Quality Growth companies is the gift that simply keeps giving. In most cases, temporary set-backs are just that; a temporary pause in a long elongated trend upwards.

Even though I readily admit, some of these share prices might have run too far too fast, for the time being, the All-Weather Portfolio won’t be selling out and might instead add more exposure in case of severe share price weakness. I say this because I have experienced the agony of selling out and then missing out through failing to get back on board again.

Sometimes securing a small profit in the here and now is not the best decision one can make. It can cost you dearly. Within this context I was reminded recently of a survey conducted by Fidelity between 2003-2013 that found dead people had achieved the highest investment return over that period.

How come? Dead people make no changes, no matter what happens in markets.

As investors, we all go through our own cycles of gaining confidence and experience, and I can truly understand taking some risk off the table, just in case. But don’t go overboard, unless you’re owning higher risk, vulnerable small caps that are seriously under threat of tanking – or your horizon is short term, or your stomach simply cannot take it (you’ll have to train it, though).

Post-August Best Ideas

In terms of where to put fresh money, I cannot help but think this year’s weakness in uranium companies equates to short-term traders throwing out the baby with the bathwater. Shares in Paladin Energy ((PDN)), probably the least-risky option locally, have halved since May.

Yes, I do understand the reluctance in trying to catch a falling knife. Besides, I am by no means that type of investor. Cue my proprietary research into All-Weathers, which also defines the mandate that rests with the earlier mentioned Model Portfolio.

From that portfolio, the one idea that springs to mind is Dicker Data ((DDR)), distributor of all things technical with a firm focus on smaller sized businesses across Australia. Dicker Data’s FY24 performance disappointed in August, because of too high operational costs, but underlying lays solid growth.

I regard Dicker Data as part of the Gen.Ai exposure inside the Model Portfolio, as the impact from the next tech revolution won’t stay limited to data centres and related beneficiaries; at some point, laptops, PCs and other devices will be sold with Gen.Ai embedded, and that will reinvigorate momentum for companies also including Officeworks ((WES)), JB Hi-Fi ((JBH)), Harvey Norman ((HVN)) and Data#3 ((DTL)).

One expression from legendary investor Peter Lynch comes to my mind regularly in 2024: you have to know what you own, and why you own it. Selling shares today that should be trading a lot higher over the next 12-14 months, but might be cheaper over the next month or so, is not what suits my style of investing.

One other idea was put forward by Morgan Stanley this morning (on Monday): Accent Group ((AX1)). It’s the broker’s number one small cap idea that has come out of the August results season.

Macquarie has selected 16 Quality small- to mid-cap companies now considered best ideas post robust performances in August:

-AUB Group ((AUB))
-Breville Group ((BRG))
-Flight Centre ((FLT))
-Fisher & Paykel Healthcare ((FPH))
-GQG Partners ((GQG))
-Integral Diagnostics ((IDX))
-JB Hi-Fi
-Lovisa Holdings ((LOV))
-Nick Scali ((NCK))
-Monash IVF ((MVF))
-Propel Funeral Partners ((PFP))
-Pinnacle Investment Management ((PNI))
-REA Group ((REA))
-Reliance Worldwide ((RWC))
-TechnologyOne ((TNE))
-Seven Group Holdings ((SVW))

More in Rudi’s Views’ Conviction Calls and Best Ideas on Thursday.

All-Weather Model Portfolio

If anyone wondered, the below is what a relatively passively managed portfolio looks like, in investment return pre-fees.

No resources. No true cyclicals. No cheap-looking low quality stragglers. No over-allocation to small caps, and no Australian banks.

Instead, there’s a little bit of gold, a few sturdy and trustworthy dividend yielders, and a strong emphasis on quality and sustainable growth, including plenty of exposure to Gen.Ai.

Hence, on the positive side we find the likes of ResMed ((RMD)), Hub24 ((HUB)), Goodman Group ((GMG)), NextDC ((NXT)) and TechnologyOne ((TNE)) and on the not so positive side the portfolio owns shares in Audinate Group ((AD8)) and IDP Education ((IEL)).

Gen.Ai – A New Section On The Website

To illustrate our ongoing confidence in the multi-years lasting impact Gen.Ai will have on life as we know it, and on the share market and financial markets in the broadest sense imaginable, FNArena has created and added a dedicated section on the website to the emerging fourth industrial revolution.

This is your newest destination for updates on data centres operators, and related beneficiaries, but also on PC retailers and every other related story we publish on the theme.

The quickest way to get there runs via the drop down menu on the black ribbon that runs across the website. Start from FNArena NEWS.

Our newest section has also been added near the bottom of the website front, squeezed in between two other sections that might deserve your attention: FNArena WINDOWS and Feature Stories.

More reading:

https://fnarena.com/index.php/2024/09/05/rudis-view-august-results-fail-to-inspire/

https://fnarena.com/index.php/2024/08/28/rudis-view-august-trends-have-darkened/

https://fnarena.com/index.php/2024/08/21/rudis-view-august-paints-a-bifurcated-picture/

https://fnarena.com/index.php/2024/08/14/rudis-view-august-results-early-beginnings/

https://fnarena.com/index.php/2024/08/07/rudis-view-august-results-polarisation-divergence/

https://fnarena.com/index.php/2024/07/31/rudis-view-what-can-august-deliver/

All-Weather Portfolio FY24 Review

The FY24 review for the All-Weather Model Portfolio can be downloaded here:
https://www.fnarena.com/index.php/download-article/?n=DE2A4552-E2C7-4DC7-0A896CE5CF68ACD8

Prior years:

FY23: https://www.fnarena.com/index.php/download-article/?n=DFC11150-CB36-C777-1AA3EDA640E2F5BF

FY22: https://www.fnarena.com/index.php/download-article/?n=DFE7241B-9CD8-61F1-1602C581A8E539C4

FY21: https://www.fnarena.com/index.php/download-article/?n=DFF82691-E53E-3CF5-17A2337D72CDB54F

FNARENA VIDEO

Dani and I have put together a video to explain our focus (and enthusiasm as investors) for GenAi, the fourth industrial revolution:

https://fnarena.com/index.php/fnarena-talks/2024/07/15/investing-in-genai-the-fourth-industrial-revolution/

SPECIAL REPORT

FNArena has published a 78 pages Special Report on GenAi, the fourth industrial revolution with lots of in-depth insights, forward projections, and useful links to companies for investors in the Australian stock exchange.

This Special Report remains exclusive for paying subscribers. Download your copy via the Special Reports section on the website.

Model Portfolios, Best Buys & Conviction Calls

This section appears from now on every Thursday morning in a separate update on the website. See Rudi’s Views for the archive going back to 2006 (not a typo).

FNArena Subscription

A subscription to FNArena (6 or 12 months) comes with an archive of Special Reports (21 since 2006); examples below.

(This story was written on Monday, 9th September, 2024. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: contact us via the direct messaging system on the website).

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